Venture Funding Picks Up

Emerging companies got a lift in the second quarter as U.S. venture capital investing climbed to $5.4 billion, a 14% increase from the first quarter, new data show.

In Southern California, entrepreneurs benefited from an even sharper pickup: $578.3 million was invested in the region, a 37% jump from the first quarter, according to the quarterly report being released today by industry trackers Ernst & Young and VentureOne.

The number of U.S. deals rose 7% to 524, while Southern California transactions surged 39% to 53.

Venture investors are considered a vital funding source for young companies. They buy ownership stakes and help manage the growing businesses, hoping to cash in if the companies are eventually sold to a larger rival or go public through initial stock offerings.

Driving the uptick was an emphasis on so-called later-stage deals, as investors continued to shy away from the riskiest and most unproven companies while pouring money into those with track records and other backers already on board.

Later-stage deals (defined as deals made with companies getting at least their third round of financing) in the U.S. accounted for $3 billion in the second quarter, up from $2.3 billion in the same period a year earlier and the most in almost four years.

“Venture firms are moving upstream,” explained Don Williams, head of Ernst & Young’s Southern California venture advisory group. “They want to invest in a product, not an idea.”

That makes it harder for fresh start-ups to land venture funding, but it also could spell trouble for venture investors themselves, Williams said. “The question is, are they feeding the pipeline with enough new deals to have adequate opportunities in later-stage deals three years from now?”

Despite the second quarter’s gains, venture investing so far this year is down from the first half of 2004 -- and way down from the height of the technology stock craze.

Through June 30, venture investments totaled $10.1 billion across the nation and $1 billion in Southern California, compared with $11.3 billion and $1.1 billion, respectively, in the first half of 2004.

In the record year of 2000, U.S. companies were flooded with $95 billion in venture funding.

Among other highlights:

* Investments in the tech and healthcare industries, two traditional favorites of venture backers, were fairly stagnant in the second quarter, but the broad “products and services” category nearly doubled from the first quarter. One big reason: Upstart insurance company Integro Ltd., based in New York, reaped $320 million -- the largest single venture investment since 2000.

* In Southern California, investments in Los Angeles County declined 21% in the second quarter from the first quarter, but that was more than offset by an 89% rise in Orange County and a 43% climb in San Diego County. Two of the largest deals involved drug development companies in the San Diego area: Somaxon Pharmaceuticals Inc., which got $55 million, and Phenomix Corp., which got $40 million. In Orange County, Lake Forest-based Orqis Medical Corp., which makes a device used in cardiac recovery, raised $23 million.

* Although initial public offerings have slowed as investors greet new stocks with caution in a choppy equity market, the merger-and-acquisition market has improved a bit, an encouraging sign for venture investors eyeing “exit strategies.” Acquirers paid $14.1 billion to buy out venture-backed companies in the first half, according to Ernst & Young, versus $23.3 billion in all of 2004. The median price paid rose to $60 million from $40 million.

In May, for example, Costa Mesa-based credit specialist Experian bought Santa Monica’s LowerMyBills.com for $330 million in cash, providing a windfall for venture backers who previously had invested a total of $13 million in LowerMyBills, Williams said.

Meanwhile, in the first half only 13 venture-backed companies went public through IPOs, compared with 67 in all of 2004.

“It’s becoming much more attractive to make an investment and sell it, versus making an investment and taking it public,” Williams said. “The center ring of the circus is the IPO market, but all the activity is off to the side in the merger market.”